How to Keep Fees Fair for Club Members

Questions Concerning Costs Often Arise as Partners Join or Depart

Rob, from the Blue Shirt Investment Club in Saratoga Springs, N.Y., writes: “In our club we have one partner leaving and a new partner entering. When we amend our partnership agreement with the county, we are required to pay a filing fee of $25. It is our intent to charge this fee to the incoming and outgoing members, and prorate it appropriately. However, when it’s time to pay the fee and show it as an expense, myICLUB.com wants to charge it to all members either by equal dollar amounts or by percentage ownership of the group.”

Rob’s question is “What would be the appropriate way to handle this situation?” Accounting for fees of all sorts in an investment club seems like a fairly straightforward question, but it has several components and actually raises some slightly complex issues.

Before I get into the details, though, it’s important to recognize that the club’s partnership agreement should clearly spell out how expenses are allocated among partners as well as who bears the costs related to a member withdrawal. It isn’t up to the club treasurer to decide how to enter these transactions in the books and it shouldn’t be a matter that’s put to a club vote each time it comes up, for reasons of both fairness and best practices procedures. If your agreement doesn’t include these details, your club should address these items the next time you amend the document.

Let’s start with the easiest part of the question: charging a fee to a withdrawing member. Both myICLUB.com and Club Accounting 3 allow for charging a withdrawal fee for a departing partner, which can be entered either as a percentage of the withdrawal or as a straight dollar amount.

If your club follows the current recommendations of Better­Investing’s sample partnership agreement, withdrawing members are assessed the actual costs related to their withdrawal, which in this case would include the county filing fee as well as any commissions related to the sale of securities. When entering a withdrawal in myICLUB.com or Club Accounting 3, just include the $25 fee in the withdrawal fee field on the withdrawal screen.

Next up: How should this filing fee be assessed on an incoming member?

One of the general rules of investment club accounting is that the member fee transaction used in Club Accounting 3 and myICLUB.com should be used only to record a penalty, such as a late fee or a bank fee charged for a check that was returned for insufficient funds. Clubs generally shouldn’t use member fees in an attempt to offset club expenses. When a member’s con­tribution is recorded as a member fee, the money doesn’t purchase units for that member, and that’s certainly appropriate in a penalty situation.

But initiation fees aren’t at all uncommon in clubs and are one of the primary exceptions to the “member fees should be used only as penalty” rule. As long as the initi­ation fee isn’t too exorbitant, it’s certainly fine for clubs to require incoming members to ante up an additional amount when joining as “proof” of their commitment to the club or, in the case of Rob’s club, as a result of a direct expense that results when a new member joins.

As Russell Malley, ICLUBcentral’s investment club accounting adviser, explains: “If the club were to record the $25 as a member payment instead of as a member fee, existing members could object that the new partner is ­getting some value for the extra $25 — units worth $25. In this case, it certainly makes sense that the new member’s initial check be split into an initial member payment and a separate member fee of $25. The new member is out of pocket the same amount but has fewer units, since the $25 fee does not buy units.”

However the club decides to approach this first payment by a new member, the club’s operating documents should spell out the amount of this fee clearly.

Now we’ll turn to the matter of recording the expense in the club’s books. When it comes to the county’s filing fee, myICLUB.com and Club Accounting 3 have two options for recording the expense. You can allocate the expense among all members according to their percentage ownership or you can allocate the expense by equal dollar amounts among all members.

Which should you choose? For most investment clubs, there’s only once choice: Allocate expenses the same way that you allocate income, capital gains and capital losses, by percentage ownership of the partners. You may only allocate expenses equally if your partnership explicitly allows for accounting for expenses in this fashion. If your partnership agreement doesn’t, then you must always allocate expenses by the partners’ percentage ownership. As the Internal Revenue Service’s 2010 instructions for Form 1065 state, “Allocate shares of income, gain, loss, deduction, or credit among the partners according to the partnership agreement for sharing income or loss generally.” The document goes on to explain, “If the partnership agreement does not provide for the partner’s share of income, gain, loss, deduction, or credit…, the partner’s share is determined according to the partner’s interest in the partnership.”

My belief is that clubs should allocate expenses by percentage ownership in all cases. This is the way that mutual funds charge their shareholders for expenses and seems to me to be a fair and equitable policy. I recognize that lively debates have ensued in clubs over whether certain expenses should be allocated equally, such as each partner’s BetterInvesting membership. The sticking point for many clubs is that if this kind of expense were to be allocated by percentage ownership, members with larger stakes in the club would pay more for their membership than those with smaller positions.

But the whole point of a club’s members belonging to BetterInvesting is that they’re provided with tools, training and knowledge that helps them to become more successful at selecting and analyzing stocks, which in turn helps the club to become more profitable. Then, as the club becomes more profitable, those with the largest number of units in the club receive more of the gains and income. As a result, those with a greater number of shares should willingly assume a greater share of expenses as long as those charges are necessary or in some way benefit the operation of the club. (If expenses aren’t necessary or don’t benefit the club, why would the club allow them?)

If you listen closely, you might hear a faint chorus of “Yes, but…” from club members around the country who just read that paragraph and object on principle to the notion that there aren’t ever cases where expenses should be allocated by equal dollar amounts to members.

I don’t expect this hotly contested question to be resolved, but will only remind you of the IRS regulations regarding equal dollar allocations of expenses: that this proviso must be included in your partnership agreement if you wish to use this method in your club.

If your club allows for expenses to be equally allocated to members, there’s a potential patch of quicksand you should avoid. This particular issue doesn’t significantly affect Rob’s club and the matter of accounting for an initiation fee paid by a single member, but it would come into play if you were using member fees paid by several or all members in an effort to offset club expenses. In cases where you’re collecting member fees, you should never use the equal allocation method of accounting for expenses. Instead, you must allocate those expenses by percentage ownership.

Whenever a member fee is recorded, the overall value of the partnership increases and the value of a unit in the club goes up as well. All members see an increase in their capital account, including the members who paid the fees. When you record an expense, it then reduces the club’s unit value.

If you allocate an expense equally by member (as opposed to allocated by percentage ownership), members who own smaller percentages of the investment club will actually be hit harder than other members who paid the same fee but own larger percentages of the club.

Douglas is ICLUBcentral's product manager, helping develop the company's programs including Toolkit 6, myICLUB.com, and the Investor Advisory Service. He is also the author of several investing books, including The Pocket Idiot's Guide to Direct Stock Investing, The Complete Idiot's Guide to Online Investing, The Armchair Millionaire, and Investment Clubs for Dummies.